08 May 2010

The Financial Collapse: Revealed?

I am a bit behind in listening to "This American Life," which I subscribe to as a podcast. I just listened to episode #405: Inside Job, it is about 39 minutes long. (There may be a way to listen to it for free, as I said, I received it as a podcast.) Truly fascinating.

Essentially, Magnetar Capital is a hedge fund that decided to buy up the lowest tranche that comprises collateralized debt obligations (CDO's), also know as collateralized mortgage obligations (CMO's) or residential mortgage back securities (RMBS's). According to the National Public Radio and ProPublica reports, Magnetar was extremely aggressive in the amounts of which it bought the "equity" (lowest) tranche and hedged against the CDO which housed their investments. If the any part of the CDO's were to fail, Magnetar would gain more money than if the CDO were to actually succeed.

The interesting ethical dilemma is that Magentar's fiduciary responsibility is with its investors. In other words, it seeks to make money for its investors regardless of any consequences it may cause. Magnetar seized a loop-hole and ran with it, to the benefit of its investors. But, at what cost? 

Not to defend Wall Street, but there are other factors that allowed a company such as Magnetar Capital to create insanely risky equity tranches also played a hand in the "financial collapse." 

  1. There was a change in policy during the Clinton administration that allowed less equity requirements when people bought homes. Thus allowing for people getting in over their head in mortgage debt. (My friend's mother is a bookkeeper and told me that pre-Clinton, a home owner needed 20% equity before purchasing a home. That requirement dropped considerably during the Clinton administration. Unfortunately, I looked for documentation on the internet, but did not find it.)
  2. Because of the dot com bubble, the Federal Reserve dropped interest rates to new lows, again allowing for people to buy real estate that perhaps was not in his/her best interest. This, coupled with lowered equity requirements, drove a housing boom. 
    1. "Yale economist Robert Shiller said in 2005, “Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. Where else could plungers apply their newly acquired trading talents?”" (Wikipedia.org).
  3. Where is the personal accountability in each home owner that knew s/he could not afford such homes? If it were only a few people, they would have ultimately only screwed themselves, so to speak, and it would not have led to any pandemic financial downfall. I know people don't like to ever blame themselves, but I feel that it is not just the system at fault. People on "Main Street" are just as greedy as those on Wall Street. 
  4. It seems obvious that if there is a weakness in the system, somebody (usually in Wall Street) will find and exploit it. That is not to say that I agree with the morality of being some sort of financial shark, but if it is legal, it will be done. 
  5. How bankers are compensated is also an issue. Many put together these low-quality CDO deals knowing that personally they would be paid bonuses based on fees that were generated just by putting together CDO's. If the CDO were to fail, the bankers had already been paid. There were no consequences if CDO's succeeded or floundered. The banks that put together were saddled in bad investments while the responsible parties had already received handsome bonuses. 
  6. I am wondering, where was the SEC during all of this? Shouldn't the agency have been a watchdog? I'm not sure, but I just wanted to mention it as something to consider.
All of this essentially led to the financial collapse. It really reminds me of Long-Term Capital Management (LTCM). In the west, we really did not feel the effects of the disintegration of LTCM, but it certainly sparked The Asian Crisis. There is a definite domino effect if you care to look for it. Wall Street is not completely to blame, but it certainly played a huge hand. The U.S. government (often times the Fed) also plays its hand in a major way with its policies and agendas. 

To me, the real question becomes how to prevent all these ricochets? One or two businesses takes down a financial system, the Fed reacts, other problems are caused. What due diligence does Wall Street really have? What personal accountability does each of us have? When should the government step into our "free" markets? I am not making any moral judgements here, but I think that it is important to understand the situation. It is complicated, and I have over-simplified it. 

The "financial collapse" continues to impact people around the globe. U.S. taxpayers are on the hook for bailing out many banks. Just consider: who is ultimately accountable? It is not a straight-forward answer, but worth contemplating. 


Post a Comment